PORTFOLIO POINT: This is a sampling of the week's best research notes. In a world of too much information, we hope our selection helps you spot the market's key signals.
With markets on edge as European leaders enter do-or-die talks to save the financial system, decisions over the weekend could decide the fate of equities for years to come. On one hand, Marshal Auerback says investors have already priced in the worst, arguing there is more risk on the upside than the downside. On the other, GMO charts its vision of the crash ahead, explaining why it will be even more painful than 2008. But whatever happens, Research Watch has you covered: find out how to trade a European fiscal deal, or study post-euro exchange rates. Meanwhile, Alphaville mourns the death of “risk free” as Absolute Returns gives its own kind a good beating. There's some highly selective investment advice from your favourite billionaires and on video, the Fed for president.
Will markets rally like it's 1998? “We think that the markets could surprise again to the upside as we have apparently discounted a double-dip recession, whereas a slowdown might be more accurate. This period might end up being closer to 1998 than 2008. The trouble with the view that we are heading for another 2008 is that all crises are different. But they do share one common element: the inability of markets to perceive that when a market discontinuity is fresh in the minds of investors (eg, 2008); it seldom repeats until that institutional memory is dissipated. Now, I believe that European banks are insolvent conditional upon the PIIGS collectively being insolvent. Clearly, this is the case for Greece (although the European Central Bank could easily forestall this if it keeps buying Greek debt), but for the others, this is unclear – and, particularly in the case of Spain and Italy, a function of the rates at which they can borrow. So while the ECB provides a liquidity backstop, they have the room to adjust. Of course, the missing ingredient is growth. Europe already looks as though it has slid into recession. I would argue that recession, as opposed to systemic risk and bank runs, is already priced into European stockmarkets.” (Marshall Auerback of Pinetree Capital, December 5)
Or will the next crash play out like it's 1929? “Historians would notice that all major equity bubbles (like those in the US in 1929 and 1965 and in Japan in 1989) broke way below trend line values and stayed there for years. Greenspan, neurotic about slight economic declines while at the same time coasting on Volcker’s good work, introduced an era of effective overstimulation of markets that resulted in 20 years of overpriced markets and abnormally high proï¬t margins. In this, Greenspan has been aided by Bernanke, his acolyte, who has continued his dangerous policy. The ï¬rst of the two great bubbles that broke on their watch did not reach trend at all in 2002, and the second, in 2009 '¦ took only three months to recover to trend. This pattern is unique. Now, with wounded balance sheets, perhaps the arsenal is empty and the next bust may well be like the old days.”
(GMO via FT Alphaville, December 6)
The death of 'risk free' '¦ “The universal pool of 'risk-free' investments has been contracting since 2008 '¦ [which] in turn has caused a major run on the few remaining 'safe assets’ out there. [It's] a situation which in itself has fuelled record low yields and negative repo rates on quality collateral, but rising yields, repo rates and haircuts on 'unsafe collateral’. Collectively, the two phenomena have choked up access to cheap secured funding. Regulatory moves to increase the amount of 'quality collateral’ held unencumbered on banks’ balance sheets '¦ have hardly helped to ease the collateral crunch '¦ There is no such thing as a principal protected investment any more – no matter how pronounced the dash for the underlying security itself is. One way or another, the investor is now prepared for the fact that he may lose principal ' either as a result of gambling in risky securities, or by paying a charge to be invested in less risky securities. You could say, the investment world has gone from a world of absolutes to a world of relative investments as and how they compare to cash deposits.”
(FT Alphaville, December 5)
The facts funds don't want you to know '¦ “I have never come across a fund manager who openly admits that his (or her) outperformance is down to luck. On the other hand, I often come across fund managers who suggest their underperformance is down to bad luck '¦ If a fund manager’s outperformance is based on skill rather than luck, wouldn’t one expect the majority of the outperformance to come from those stocks with the highest weights in the portfolio? This seems a reasonable assumption given that one would expect any rational fund manager to allocate the most capital to his/her highest conviction ideas. However, in a study conducted by UK consulting firm Inalytics, 39 of 42 Australian fund managers who outperformed their benchmark owed their outperformance to the 'underweights’ in the portfolios – suggesting that human error is not only the source of underperformance but perhaps also of some of the outperformance. Bestinvest produces an annual survey called Spot the Dog '¦ [which shows] over £23 billion is currently managed in so-called dog funds, an increase of no less than 74% since the previous report '¦ The members of that exclusive club have a history of serial underperformance, yet they will generate in the region of £350 million of fees to their firms this year despite the obvious value destruction '¦ According to an unpublished report conducted by IBM, our industry destroys $US1300 billion of value annually – a staggering 2% of global GDP. (Niels C. Jensen, Absolute Return Partners, December 2011)
The drug den of Wall Street '¦ “Frankly, I am concerned that Wall Street is becoming little more than a glorified crack house. Day after day, the sole focus of Wall Street is on more sugar, stronger sugar, Big Bazookas of sugar, unlimited sugar, and anything that will get somebody to deliver the sugar faster. This is like offering a lollipop to quiet down a two-year old throwing a tantrum, and expecting that the result will be fewer tantrums. What we have increasingly observed over the past decade is nothing but the gradual destruction of the ability of the financial markets to allocate capital for the benefit of future growth.” (John Hussman of Hussman Funds, December 4)
Here's what currencies will look like if the EU fails '¦
(Nomura, December 5)
How to trade a European fiscal deal '¦ “1)Look for a bounce in the markets. If the plan shows any signs of working '¦ there will be a visible mood of relief. 2) Get behind the DAX. The big German exporters have been the only real winners from the euro. An artificially low exchange rate has kept their goods a lot cheaper on the world’s markets than they otherwise would be '¦ A 'fiskalunion' will be the continuation of the same polices, except on steroids '¦ The big German companies that make up the DAX will do well. 3) Get into the peripheral country banks. No sector of the stockmarket is more bombed out than Greek, Italian or Spanish banks '¦ But under the fiskalunion the banks will start to recover ... [and] will get low-cost funding from the European Central Bank. 4) Short the rest of the southern European markets. All the peripheral countries will have grinding austerity packages imposed on them '¦ It will be very tough for any companies operating in those markets – and their share prices can be expected to suffer." (Matthew Lynn via Market Watch, December 7)
An ambitious tech float '¦ “Some of the Silicon Valley's most important companies, including Intel, Google, and Yahoo, were cofounded by immigrants. Yet America's creaky immigration system makes it difficult for talented young people born outside of the United States to come to the Bay Area '¦ A new company called Blueseed is seeking to bypass the political process and solve the problem directly. Blueseed plans to buy a ship and turn it into a floating incubator anchored in international waters off the coast of California '¦ Blueseed founder Max Marty acknowledged that it would be better for America to reform immigration laws and thereby make his company unnecessary. But in the meantime, Marty and his team are hard at work tackling the practical obstacles to making their vision of a floating, year-round hack-a-thon a reality. Within the next year, they're hoping to raise a venture capital round large enough to lease or buy a ship with space for around a thousand passengers. If Blueseed's audacious hack of the immigration system is successful, it will not only open up Silicon Valley to a broader range of entrepreneurs, it will also shine a spotlight on the barriers American law places in the way of immigrants seeking to start businesses in the United States.” (Ars Technica, December 2)
Billionaires' best advice '¦ “Mikhail Prokhorov, Russian billionaire entrepreneur: 'Keep your back straight and don’t fidget’ ' a piece of Russian folk wisdom.
Donald Trump, real estate mogul: 'My father, Fred C. Trump, told me to know everything you can about what you’re doing. He believed in being thorough and was wary of blind spots.’
Eli Broad, American businessman: 'Don’t bet the farm.’
Randal J. Kirk, founder, chairman and chief executive of New River Pharmaceutical: 'Good deals are like bus stops; there is one on every corner.’ Told to me by Red Robertson of Grundy, Virginia, who invested in my first deal. The advice illustrated he was not so interested in the deal as in my dedication to it. One invests in the guy behind the deal, above all else'." (Matthew G. Miller and Peter Newcomb, Bloomberg, November 30)
Video of the week: A presidential dream team '¦ “Jim Rogers, chairman of Rogers Holdings and legendary investor, reveals two presidential candidates dead or alive that will whip the US economy back into shape.”
(The Street, December 7)